Covenant

Covenant

A financial covenant is a promise or a condition that has to be fulfilled by the borrowing party.

Example: a covenant may be that the borrowing company has to maintain a specific amount of cash & cash equivalents for the entire duration of the loan.

Some other covenants are maintaining financial ratios (such as P/E ratio) within a limit.

Violation of such covenants may lead to penalties or calling off of the loan.

In this promise or contract, the company have to maintain the terms and conditions of contract. 

This contract has given by company to other company so there is a middle man for two sides settlement.  

If the borrower company fail to maintain the terms and conditions of contract then they have to pay the penalty.